Simple Rules For MLP Investing

In this article, I will show the correlations between (1) consensus analyst ratings and total returns; (2) projected three-year distribution CAGR (Compound Annual Growth Rate) numbers and total returns; (3) the Distribution/DCF Ratio and total returns and (4) the Distribution/DCF Ratio and distribution growth. Beneath a thick coating of metrics in this article on MLPs (Master Limited Partnerships) on stocks like Enterprise Products Partners (NYSE:EPD) and Kinder Morgan Energy Partners (NYSE:KMP) - is a story on how investing can be too much like High School for the overly casual investor.

Let's get nostalgic -- real nostalgic. Let's say we are all "men of a certain age" - and remember back to when we were in high school. I'll tell you how it was for me in the early 70s - and you will all just nod your head in agreement as if your life was not that different from my own. Like all teens - I did not have a clue when it came to the big topics like life, spirituality, happiness, fulfillment, sex and money. I listened hard for the right clues. Given the abundance of conflicting advice, I was pretty sure the right clues were out there. I was unfortunate to think I found a few. It took more than a decade to unlearn most of the things I learned from listening to other fellow teens that I thought knew more than me. I alone knew the secret that it did not take much to know more than me. I had no idea how little was known by everyone else.

I have done a fair amount of testing on a decent sized pool of volunteer guinea pigs that are my fellow investors. They have answered surveys in return for the data that I provide. I have a potentially unique impression that for most retail investors, investing is too much like high school. If investing for you is acting with a very thin coat of self confidence that is covering mountains of uncertainty - then you know what I mean. If investing is still listening hard for the clues from others that you think know more than you - then you know what I mean. If you are slowly getting the impression that no one ever knows what they are talking about in any article on investing - then you are beginning to think like a high school graduate who has had time to meditate on those prior years.

This is a data intensive article on MLPs. But if you start to forget that this is also a story that echoes with a search for "clues" - and an over dependence on the opinions of others - that was our MO in our high school past, then you may miss the big lesson. With that warning, let's get started.

The 2013 numbers

MLP Midstream Data 12-31-13

Yields are based on the Q4-13 distribution. Under the 'year to date' header, the change in the distribution is actually the change since Q4-13 - or the change over the last twelve months. The change in the target, EPS, DCF and CAGR is the percentage change in the consensus 2013 projection that has happened since the beginning of the year.

The (price change only) Alerian MLP index [the ^AMZ - which includes other MLP sectors] is 20.44% year to date.

The Alerian MLP index ETN AMJ is 20.51% and with dividends is 26.21%.

The S&P 500 index ETF SPY is 29.69% and with dividends is 32.04%.

The Russell 2000 index ETF IWM is 36.81% and with dividend is 38.49%.

With the 10yr Treasury @ 3.03% & the sector average yield [on Q4 distrib's] at 5.77% - the spread is 274 bps.

Click to enlarge

Explaining many of the outlier performances

While the sector average unit price appreciation was 32.30% on this non-cap weighted coverage universe, the sector median was only 25%. The median differed from the mean due to atypical price appreciation in AMID and XTEX along with superior performances from a few others. AMID had its existing general partner sell AMID to a better general partner. The new general partner has existing properties that it can drop down to AMID. This transaction significantly changed the growth outlook for AMID. XTEX and its general partner merged with Devon. That transaction significantly changed the growth outlook for XTEX and XTXI.

There were a few MLPs that significantly underperformed. EPB's unit price fell due to shifting projections towards much lower distribution growth. OKS and WPZ fell because their EBITDAs are sensitive to the NGL pricing. HEP fell due to falling DCF projections - which is a bad thing for a MLP, which began with low distribution coverage.

The correlation data begins

In looking for simple rules to success, I will first provide data on how following the consensus analyst buy and sell recommendations one could find at Yahoo Finance would have done for you in 2013, 2012 and 2011.

For 2013 - Yahoo Consensus Analyst Ratings and MLP performance

The following companies had buy ratings under 2.249 (in the Yahoo rating system, the lower numbers are better ratings) at the beginning of the year: ACMP, AMID, APL, DPM, EPD, GEL, MWE, NGLS, OILT, PAA, RGP, SXL, TLLP, TLP, WES and WPZ. Their mean price gain for the year is 35.29%. Their mean total return for the year is 42.04% - and 9 of the 16 beat the sector median yearly price gain of 25%.

The following companies had ratings over 2.249 at the beginning of the year: BKEP, BPL, BWP, EPB, EEP, ETP, EXLP, HEP, KMP, MMP, NS, OKS, SEP, TCP and XTEX. Their mean price gain for the year is 26.23%. Their mean total return for the year is 33.99% - and 7 of the 15 beat the sector median yearly price gain.

The best rated MLPs: The following companies had buy ratings under 2.0 at the beginning of the year: ACMP, AMID, APL, EPD, GEL, MWE, NGLS, OILT, PAA, RGP, TLLP, TLP, WES and WPZ. Their mean price gain for the year is 35.17%. Their mean total return for the year is 42.02% - and 8 of the 14 beat the sector median yearly price gain.

Taken as a group, the better rated stocks won. But when looked upon one at a time, 56.25% of the better rated stock beat the sector median while 50% of the lesser rated stocks beat the median. That is not much of a difference!

For 2012 - Ratings and MLP performance: The following companies had buy ratings under 2.249 at the beginning of the year: APL, ACMP, CMLP, EEP, EPD, EROC, EXLP, GEL, MWE, NGLS, PAA, RGP, WES and XTEX. Their mean price gain for the year is -2.06%. Their mean total return for the year is 4.68% - and 7 of the 14 beat the sector median yearly price gain [-2.62%].

The following companies had ratings over 2.249 at the beginning of the year: BPL, BWP, CPNO, DPM, EPB, ETP, HEP, KMP, MMP, NS, OKS, SEP, SXL, TCP, TLP, WPZ, NMM, MMLP and TGP. Their mean price gain for the year is -3.03%. Their mean total return for the year is 3.93% - and 7 of the 19 beat the sector median yearly price gain.

The best rated MLPs: The following companies had buy ratings under 2.0 at the beginning of the year: APL, ACMP, EPD, EXLP, GEL, MWE, NGLS, PAA, RGP and WES. Their mean price gain for the year is 5.53%. Their mean total return for the year is 12.10% - and 7 of the 10 beat the sector median yearly price gain [-2.62%].

For 2011 - Ratings and MLP performance: The following companies had buy ratings under 2.249 at the beginning of the year: CMLP, EPB, EPD, ETP, EXLP, GEL, MMP, MWE, OKS, RGP, WPZ and TGP. Their mean price gain for the year is 8.57%. Their mean total return for the year is 15.03% - and 6 of the 12 beat the sector average yearly price gain of 8.32%.

The following companies had ratings over 2.249 at the beginning of the year: APL, BPL, BWP, CHKM, CPNO, DPM, EEP, EROC, HEP, KMP, NGLS, NS, PAA, SEP, SXL, TCP, TLP, WES, XTEX, NMM and MMLP. Their mean price gain for the year is 8.19%. Their mean total return for the year is 15.08% - and 9 of the 21 beat the sector median yearly price gain.

The best rated MLPs: The following companies had buy ratings under 2.0 at the beginning of the year: CMLP, EPB, EPD, EXLP, GEL and RGP. Their mean price gain for the year is 0.69%. Their mean total return for the year is 7.22% - and 2 of the 6 beat the sector median yearly price gain [8.32%].

A quick summaryon the ratings data - Following the consensus buy and sell recommendation fails to lead to sector beating performance.

I will move on to another metric that should logically lead to sector beating return - following the analyst three-year distribution CAGR (compound annual growth rate) projections.

For 2013 - High CAGRs and Year to Date Returns: The following companies had CAGRs of 4.5% or more: ACMP, AMID, APL, BKEP, CMLP, DPM, EPD, EQM, GEL, HEP, KMP, MMP, MWE, NGLS, OKS, OILT, PAA, SEP, SXL, TLLP, WES, WPZ and XTEX. Their mean price gain for the year is 36.68%. Their mean total return for the year is 43.28% - and 10 of the 23 beat the sector average yearly price gain of 32.47%. 14 of the 23 beat the sector median yearly price gain of 25%.

The following companies had CAGR estimates under 4.5%: AMID, BPL, BWP, EPB, EEP, ETP, EXLP, KMP, NS, RGP, TCP and TLP. Their mean price gain for the year is 26.54%. Their mean total return for the year is 35.34% - and 3 of the 12 beat the sector average yearly price gain. 4 of the 12 beat the sector median yearly price gain.

For 2012 - High CAGRs and Year to Date Returns: The following companies [weeding out high gainers APL, EROC and XTEX] had CAGRs of more than 4.5%: CPNO, DPM, EPB, EPD, GEL, HEP, MMP, MWE, NGLS, OKS, PAA, RGP, SXL, WES and WPZ. Their mean price gain for the year is 5.99%. Their mean total return for the year is 12.03% - and 9 of the 15 beat the sector average yearly price gain [-2.62%].

The following companies had CAGR estimates under 4.5%: BPL, BWP, CMLP, EEP, ETP, EXLP, KMP, NS, SEP, TCP, TLP, NMM and MMLP. Their mean price gain for the year is -11.90%. Their mean total return for the year is -4.21% - and 3 of the 13 beat the sector average yearly price gain.

For 2011 - High CAGRs and Year to Date Returns: The following companies (weeding out high gainers APL, EROC and XTEX) had CAGRs of more than 4.5%: BPL, CMLP, DPM, EPB, EPD, GEL, HEP, MMP, MWE, NGLS, OKS, SEP, SXL, WES and WPZ. Their mean price gain for the year is 18.25%. Their mean total return for the year is 24.38% - and 11 of the 15 beat the average yearly price gain of 8.32%.

The following companies had CAGR estimates under 4.5%: BWP, CPNO, EEP, ETP, EXLP, KMP, NS, PAA, RGP, TCLP, TLP, NMM, MMLP and TGP. Their mean price gain for the year is -6.80%. Their mean total return for the year is 0.08% - and 2 of the 14 beat the sector average yearly price gain.

Quick summaryon CAGR data - Following CAGR projections appears to be a way to generate sector beating returns.

In making my CAGR projections, I have access to several good sources for those projections. Odds are that you lack access to most of those numbers. Are there metrics that can help you fine tune a consensus number that lacks enough inputs to have much confidence in that number? Yes, there is. There is a strong correlation between forward distribution growth and the current distribution to DCF (distributable Cash Flow) ratio. What follows is the correlation data for 2013, 2012 and 2011 between distribution increases and the Distribution to DCF ratio - and the data for the same periods between Total Returns and the Distribution to DCF ratio.

For 2013 - Distribution Increases and the Distribution/DCF Ratio: The following companies had distribution/DCF ratio under 77% before the Q1-13 distribution announcements: ACMP, BKEP, EPD, EQM, EXLP, MMP, OILT, PAA, SXL, TLLP and TLP. Their mean distribution gain between Q4-13 and Q4-13 was 13.83%.

The following companies had distribution/DCF ratio more than 77% but under 90% before the Q1-13 distribution announcements: CMLP, GEL, HEP, TCP and WES. Their mean distribution gain since Q4-12 was 8.7%. The following had distribution/DCF ratios more than 90%: AMID, APL, BPL, BWP, DPM, EPB, EEP, ETP, KMP, MWE, NGLS, NS, OKS, RGP, SEP and WPZ. Their mean distribution gain since Q4-12 was 5.06%.

For 2013 - The Correlation of Total Returns to Distribution/DCF Ratios: The following midstream [non-marine and non-G&P] companies had Distribution/DCF ratios of less than 85% (the sector median at the beginning of 2013): BKEP, EPD, GEL, MMP, OILT, PAA, SXL, TLLP and TLP. Their mean price gain since the beginning of the year is 35.22%. Their mean total return since the beginning of the year is 40.87% - and 6 of the 9 beat the sector average yearly price gain of 35.43%.

The following companies had Distribution/DCF ratios of more than the sector average of 85% : BPL, BWP, EPB, EEP, ETP, HEP, KMP, NS, OKS, SEP, TCP, WPZ. Their mean price gain since the beginning of 2013 is 15.28%. Their mean total return since the beginning of the year is 22.91% - and 3 of the 12 beat the sector median yearly price gain.

For 2012 - Distribution Increases and the Distribution/DCF Ratio: I should note that the following calculation was done only for MLPs with distributions over $0.10/unit in Q2-10 - with this done to screen out APL, EROC and XTEX. This was also done in the 2011 numbers that are shown in this article and in my prior calculation that are not shown here. These three cut their distributions in 2009. They fell more in 2009 and 2010 - and had stronger recoveries once their distributions were re-started. Their high volatility had a strong influence on "average" numbers - so they were excluded because of that volatility.

The following companies had distribution/DCF ratio under 77% before the Q1-12 distribution announcements: EPB, EPD, MMP, NGLS, OKS, PAA, SXL, TLP and WES. Their mean distribution gain between Q4-11 and Q4-12 was 14.57%.

The following companies had distribution/DCF ratio more than 77% but under 90% before the Q1-12 distribution announcements: EXLP, HEP, KMP, MWE, TCP, WPZ and TGP. Their mean distribution gain since Q4-11 was 6.55%.

The following had distribution/DCF ratios more than 90%: BPL, BWP, CMLP, CPNO, DPM, EEP, ETP, NS, RGP, SEP, NMM and MMLP. Their mean distribution gain since Q4-11 was 1.97%.

For 2012 - The Correlation of Total Returns to Distribution/DCF Ratios: The following midstream [non-marine and non-G&P] companies had Distribution/DCF ratios of less than 85% (the sector median at the beginning of 2012): EPB, EPD, GEL, HEP, MMP, OKS, PAA, SXL, TCP and TLP. Their mean price gain since the beginning of the year is 13.09%. Their mean total return since the beginning of the year is 19.09% - and 8 of the 10 beat the sector average yearly price gain of -2.62%.

The following companies had Distribution/DCF ratios of more than the sector average of 85%: BPL, BWP, EEP, ETP, KMP, NS, SEP and WPZ. Their mean price gain since the beginning of 2011 is -14.2%. Their mean total return since the beginning of the year is -7.53% - and 1 of the 8 beat the sector average yearly price gain.

For 2011 - Distribution Increases and the Distribution/DCF Ratio: This calculation done only for MLPs with distributions over $0.10/unit in Q2-10 - with this done to screen out APL, EROC and XTEX.

The following companies had a distribution/DCF ratio under 77% before the Q1-11 distribution announcements: EPB, EPD, EXLP, MMP, MWE, NGLS, PAA, SXL, TLP, WES, WPZ and NMM. Their mean distribution gain between Q3-10 and Q3-11 was 8.14%.

The following companies had a distribution/DCF ratio more than 77% but under 90% before the Q1-11 distribution announcements: CMLP, DPM, GEL, OKS, SEP and TCLP. Their mean distribution gain since Q3-10 was 7.06%.

The following had distribution/DCF ratios more than 90%: BPL, BWP, CPNO, EEP, ETP, HEP, KMP, NS, RGP, MMLP and TGP. Their mean distribution gain since Q3-10 was 2.98%.

For 2011 - The Correlation of Total Returns to Distribution/DCF Ratios: The following midstream (non-marine and non-G&P) companies had Distribution/DCF ratios of less than 85% (the sector median at the beginning of 2011): EPB, EPD, GEL, MMP, OKS, PAA, SXL, TCLP, TLP and WPZ. Their mean price gain since the beginning of the year is 15.88%. Their mean total return since the beginning of the year is 22.01% - and 6 of the 10 beat the sector average yearly price gain of 8.32%.

The following companies had Distribution/DCF ratios of more than the sector average of 85%: BPL, BWP, EEP, ETP, HEP, KMP, NS and SEP. Their mean price gain since the beginning of 2011 is -1.89%. Their mean total return since the beginning of the year is 4.63% - and 1 of the 8 beat the sector average yearly price gain.

The lesson I draw from these numbers.

While analyst ratings matter when it comes to understanding valuations, and while analyst ratings can guide you to choosing some lower risk options, analyst ratings fail to assist you in having a winning portfolio over the next 12 months. And that has been the case year after year.

CAGR awareness matters and the distribution/DCF ratio matters. But utilizing these tools takes some extra work. The CAGR projections I use are conservative consensus numbers that are justified by the distribution/DCF ratio. The Yahoo Finance 5-year CAGR projections for MLPs are not good projections. I have provided that evidence in a prior article.

So what were the life lessons that one can apply to your investing behavior?

(1) If you are still listening for clues (or hot tips about individual stocks) - then you are trying to implement a flawed strategy. If you think you can find a clue in the ramblings of others - then you are "lost" and on the way to being "lost and misguided." One can even be charged a fee for being misguided.

(2) Listen to the numbers until the numbers tell their story. I tried to make this an article where the numbers did the talking. For example - most investors are listening to people who are writing that "Enterprise Products Partners (or Kinder Morgan Energy Partners) is a great stock." I make the argument that retail investors should listen to the numbers that say that "distribution coverage is a great attribute." Such investors can then see which stocks currently have that attribute at an attractive price.

(3) There is probably a reason why the analysts fail to do a long look back on the prior year - a review that includes their beginning of the year projections. Such an analysis would show you just how wrong their headline buy, hold and sell recommendations were. I still believe that the analyst reports are very useful. I harvest their reports for data. But I construct my own conclusions based on their consensus data. This is something that the average investor fails to do. Even when they use a full service brokerage, they fail to read the reports. There is a lot of irony in that reality. Investors have the time and the appetite to skip from one headline to another - reading them all - with some of them taking the time to argue with each other over dueling headlines. But there is no real value in the headlines' recommendations. At the same time, investors fail to allocate the time or generate the appetite to read and digest the content the analysts produce - which is where the real value resides - even if it is well hidden in obfuscation.

It is just like when we were teens, using the argument that everyone else is (fill in the black with "going to that party" or "wearing that short of a dress" or "having hair that long"). And your mom or dad relies with "and if everyone else is jumping off a bridge - would you have to do that, too?" And too many retail investors have grown up to be adults who act like the key to investment success is seeking the next great stock tip from last year's hottest stock guru. The average investor falls dramatically short of achieving results that tie the S&P 500 because they are following the kind of strategy they believe that everyone else is following. They are investing like high school students would - and following the changing opinions of others.

(4) I will argue that one should make a diversified assortment of choices among the candidates with a good chance of success due to their metric attributes. While it is the case that not all of the stocks with "winning attributes" will turn out to be winners in a given year, the universe of winning attribute stocks significantly beats the universe of lower attribute stocks.

(5) Winning in a given year still takes some luck. A good plan will still - at times - fail. Why? Because "winning attributes" can succeed as a group while failing in a significant minority of instances. Don't give up on a good plan just because if it does not, at first, succeed. Take the time to make a plan with which you will stick.

Disclosure: I am long CMLP, DPM, EPD, GEL, KMP, MMP, MWE, WES, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.